While borrowing for investment purposes is hardly controversial, it can quickly become so when the bank loan represents a lien on state assets. And the borrower is Saudi Arabia. News leaked over recent days that the Kingdom’s Public Investment Fund may draw down as much as $5 billion in a bank loan to accelerate the nation’s steps toward economic diversification.
This approach to building an asset portfolio is aggressive for a sovereign fund based in an emerging market. We see three potential problems:
Investment Risk. The Public Investment Fund is an established institutional investor with deep experience in venture investing. But return expectations can shift suddenly and deals go sour quickly. There is a material difference between borrowing for open-pool allocation decisions and, say, issuing a bond to cover a project outlay, starting with transparency in the use of proceeds.
Market Risk. Saudi Arabia is undergoing a dramatic economic transformation. The outcome is unknown, although officials are unwavering in enthusiasm over catapulting the nation beyond the oil era. Mix that reality with regional political unrest—especially in the volatility of the feud between Riyadh and Tehran—and you could see international confidence in the region falter rapidly.
Political Risk. While Saudi Arabia does not have a strict Shariah-compliant financial system, many institutions embrace tenets of Islamic finance. In this context, simply stated, borrowing for investment purposes is prohibited. Fundamentalist religious leaders could bundle this leveraging activity and other transactions with still-controversial social reforms to paint a picture of a reckless government.
To be fair, details of the bank loan are scant. It lingers in the concept stage. The government, although not the sovereign fund, has borrowed from financial institutions in the past without much controversy. In the current setting, Riyadh may guide a syndicate of players to participate in the arrangement as a type of milestone to affirm market-access privileges in the future.
A bank loan at $5 billion is chunky, but it has context. The still-unconfirmed Saudi borrowing represents a small proportion of the crudely-estimated $230 billion in assets now held by the Public Investment Fund. Importantly, the sovereign fund could be a prime beneficiary of the forthcoming initial public offering of Saudi Aramco, boosting its asset base significantly. ■
Our Vantage Point: Despite domestic confidence in the economic trajectory, outsized financing activity telegraphs country-risk issues. International investors will likely remain circumspect about Saudi opportunities.
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Image: Saudi Arabia introduced sweeping economic reforms in April 2016. Credit: Trafawma at Can Stock Photo Inc.